Risk to growth could rise if martial law fear spreads

The Philippine economy is set to continue holding up well in the short term as economic reform progresses, but greater risk lies over the medium term if investor caution over the threat of a nationwide martial law and other policy concerns prevail, Capital Economics said in its latest report on the country.

“If investment starts to slow sharply, medium-term growth prospects will suffer,” the London-based research consultancy warned said in its report, Emerging Asia Economic Weekly, released over the weekend.

The report appeared to be more upbeat about the near term.

“One year since coming to power, President Duterte of the Philippines has not been the disaster for the economy that some feared. His wisest move has been to hand over responsibility for economic management to his respected finance minister, Carlos Dominguez [3rd], who in turn has pushed through some useful reforms,” it said.
The economy remains one of the fastest growing in the region, it said, pointing out that over the next year at least, the economy should continue to grow rapidly, helped by a combination of low interest rates, buoyant consumer sentiment and rapid government spending.

Growth forecast at 6.5%
Capital Economics forecasts 6.5 percent growth for the Philippines this year, lower than the 6.9 percent expansion recorded in 2016. The government has set a growth target of between 6.5 percent and 7.5 percent for 2017.

The report said that for the most part, the President has stuck to his campaign promise by staying out of the day-to-day running of the economy, and instead, delegated economic management to Dominguez.

It lauded Dominguez for living up to his reputation as a safe pair of hands, and has provided some reassurance to investors concerned about Duterte’s controversial domestic policies.

“Encouragingly, the government has started making progress in this area. A comprehensive tax reform deal, which raises indirect and corporate taxes while reducing income tax, passed through the House of Representatives…,” the firm said.

Capital Economics was referring to the Tax Reform for Acceleration and Inclusion Act (Train), which consolidated Package One of the government’s Comprehensive Tax Reform Program (CTRP) with 54 other tax-related measures.

The CTRP seeks to make the country’s tax system simpler, fairer and more efficient. Among the tax policy reforms proposed in CTRP are broadening the value-added tax base while retaining exemptions for seniors and persons with disabilities; updating the excise tax rates for fuel and automobiles; and lowering personal income tax rates to align these with Association of Southeast Asian Nations benchmarks.

“The finance ministry has estimated that the reforms will raise 0.9 percent of GDP in extra revenue in 2018. Although the bill still needs to pass through the Senate, we expect the tax reform to become law by the end of 2017,” it added.

Capital Economics also mentioned that Duterte has made several other useful interventions, such as the nationwide smoking ban; ordering government agencies to offer free contraceptives to reduce the number of unwanted pregnancies, which is seen as a crucial step in curbing the rapid pace of population growth, reducing poverty and raising the number of women in the formal labor force.

It said improved political stability, coupled with changes to the business environment, helped trigger an acceleration in investment growth and a rise in the country’s low investment rate, which has been the Achilles heel of the economy for a long time.

Risks
“However, these achievements risk being overshadowed by a string of inflammatory comments and policy changes which have raised concerns in the minds of investors over Duterte’s judgement and commitment to the rule of law,” it pointed out.

It stressed that the President’s war on drugs has generated negative headlines across the world; his threat to upend the country’s foreign policy by “opening an alliance” with China, risks undermining its much more important relationship with the US; and threats to declare martial law across the whole country have led to worrying comparisons with the disastrous presidency of former strongman Ferdinand Marcos.

“The bigger risks are over the medium term. The Philippines’ own history shows how poor leadership and political uncertainty can hold back an economy,” it said in a tone of warning.

The report cited signs that the country’s economic performance was being put at risk by Duterte, such as: the underperformance of the stock market, which rose by only 0.2 percent since the start of the administration; drop in investment inflows; and the fall in foreign direct investment pledges.

The latest data showed that foreign portfolio investments in the first five months of the year registered a net outflow of $543.79 million, reversing a $178 million net inflow a year earlier.

During the five-month period, foreign portfolio investment inflows reached a total of $6.38 billion, down from $7.11 billion a year earlier, while outflows totaled $6.92 billion, down from $6.93 billion in the comparative period.

Meanwhile, investment pledges in the county for the first quarter of 2017 fell 12.8 percent to P22.9 billion from P26.2 billion.